What Happens to Your 401(K) When You Change Jobs?June 13, 2022
Taking advantage of an employer-sponsored 401(K) account is one of the best ways to save for retirement. For many people, a strong 401(K) matching program can be one of the primary incentives that might convince them to accept a job.
But what happens when you decide to switch jobs? Do you lose all the progress you’ve made? What can you do to retain as much of your retirement savings as possible?
We’ll answer all those questions and more in the article below.
Where Does Your 401(k) Go?
When you leave a company, your 401(k) depends on their internal policy and the amount of money in your account. If you have between $1,000 and $5,000 in the 401(k), the company is legally allowed to close out the account and transfer the balance to your Individual Retirement Account (IRA). They will send you a check for the remaining amount if you don’t have an IRA.
If you have less than $1,000 in the account, the company is allowed to automatically send you a check for the remaining amount. Those who have more than $5,000 in the account are allowed to keep the money where it is.
However, keeping your money in an old 401(k) may not be the best way to go because you’re likely to forget about your 401(k) if you don’t move it. And some companies charge an extra fee for managing a 401(k) if you’re no longer an employee.
How to Manage Your 401(K) When You Change Jobs
When you leave a company, don’t forget about your 401(k). Here’s how to handle your retirement account and which options are available to you.
Roll it over into an IRA
The most popular option for investors is to roll over their old 401(k) into a new or existing IRA. An IRA is a retirement account that is not tied to a particular employer. Rolling your 401(k) into an IRA is free and fairly straightforward.
An IRA provides more investment choices than a 401(k). Some 401(k)s have high fees and few investment options. If you have an IRA, you can pick low-cost funds that will aim to match the market.
Make sure to roll over your 401(k) into the right kind of IRA. There are two types of retirement accounts: traditional and Roth. A traditional 401(k) or traditional IRA lets you deduct contributions on your taxes, but you’ll have to pay taxes on any withdrawals later on. A Roth 401(k) or Roth IRA lets you withdraw money tax-free in retirement, but you won’t be able to deduct contributions.
You should understand what kind of 401(k) you have so you can roll it over to the same kind of IRA. For example, if you have a traditional 401(k), move it over to a traditional IRA.
If you decide to purposely move a traditional 401(k) to a Roth IRA, this will effectively convert your traditional 401(k) into a Roth IRA. Be aware that you will have to pay taxes on the amount rolled over.
Roll it over into a new 401(k)
If you don’t have an IRA and don’t want to open one, you can roll over the money into your new 401(k) – assuming your current company offers one. The downside to rolling it over into another 401(k) is that you’ll be limited to investing in what your employer offers.
Most experts recommend rolling the money to a new IRA, where you can have more freedom in what you invest in.
Why You Shouldn’t Cash Out Your 401(K)
When you’re leaving a company, it can be tempting to tap your 401(k) and use the proceeds to pay off debt, go on vacation or treat yourself.
But cashing out your 401(k) can have major financial consequences. First, you’ll likely pay taxes and an early withdrawal fee, which can equal thousands or even tens of thousands of dollars depending on the total balance.
For example, let’s say you have $10,000 in your 401(k), and you decide to cash it out. You receive a $10,000 check, but when tax time comes, you have to declare the $10,000 as income on your taxes. Including taxes and fees, you’ll only get $6,100, or 61% of the total amount. This means you’ve effectively handed over 39% of your 401(k) balance to the government.
The biggest reason you shouldn’t cash out your 401(k) is that you could miss out on decades of compound interest. For example, let’s say you’re 25 years old and cash out $10,000 from your 401(k). In 40 years, that amount would be worth $149,745 with a 7% average return.
However, if you’re close to retirement age, rolling over your 401(k) may not be beneficial. If you have a 401(k) from a former employer, you can access it starting at age 55 without having to pay an early withdrawal fee. People who plan to retire early may benefit from not moving their 401(k).
Keep Track of the Rollover
If you receive a check from the 401(k) provider, you only have 60 days to deposit it into an IRA or new 401(k). If you don’t roll over the money before the 60 days have elapsed, then you will be charged an early withdrawal fee worth 10% of the amount. You may also be required to pay income taxes on the amount. These fees will stand even if you do end up depositing the money into an IRA or new 401(k).
For example, if you deposit the 401(k) balance 70 days after receiving it, you will still be assessed those fees and penalties.
There are companies that can simplify the rollover process. Capitalize offers free help moving your old 401(k) into a new or current IRA. There are no fees or minimum balance requirements.
Some companies will let you do a direct rollover where the 401(k) funds are sent straight to the IRA provider. Before you initiate a rollover, ask if this is an option; it will save you a lot of time and headache if it is.
There can be many things to accomplish when switching jobs, but your 401(k) can be one of the easier things. Be sure to research the best option for you and understand how your retirement plan works at your previous and new jobs. By knowing your options, you’ll be able to ensure a better outcome for your future retirement.